America's Other Maturities Dilemma

This column is about relationships between commercial real estate and money. Under current recession conditions, the outlook for commercial properties will be greatly influenced by the amount of federal funds used to stimulate business and consumer spending and bolster jobs.

But the government will be limited by the amount of federal funds allocated to entitlements for elderly households, including Social Security, Medicare and Medicaid. Those programs are guaranteed by laws that expand payments as the elderly population grows.

The retirement of millions of Baby Boomers will vastly increase federal spending. Persons 65 and over comprise 13% of all Americans in 2010, but will be 16% in 2020. Unless entitlement laws are changed, such spending will increase.

Remedial changes could include raising the retirement age to 70, cutting back on Social Security, Medicare, and Medicaid benefits (at least for high-income households), and raising taxes.

So far Congress and the Obama Administration have been unwilling to consider such changes. The paralysis is caused by the political power of the elderly, who vote more than any other age group. Based on voting behavior in recent presidential elections, voters 65 and older will be 20% of all actual voters in 2010 and 25% in 2020.

According to the administration's budget forecast, total federal spending from 2011 through 2020 will equal $45.8 trillion, compared to tax receipts of $37.3 trillion, assuming a full recovery from the recession. The $8.5 trillion gap shows that Washington politicians believe the American people won't accept the tax increases and entitlement cuts necessary to pay for the services they demand.

Economist Robert Samuelson's analysis of the proposed budget shows that almost $20 trillion of the $45.8 trillion total federal spending through 2020 will consist of Social Security, Medicare and Medicaid.

If entitlement programs aren't altered soon, the federal government won't be able to fund such necessities as defense, transportation, education and infrastructure. Revenues certainly won't be adequate to help owners of commercial real estate cope with the huge number of defaults likely to appear in 2010 through 2016, or help homeowners to cope with millions of foreclosures.

The commercial mortgage problem will be especially acute because of the huge surge in mortgages originated from 1999 through 2007. Those were made at high loan-to-value ratios, high prices and low interest rates. These mortgage originations total $1.5 trillion — 16 times more than the $92.4 billion originated in the preceding eight years, according to Federal Reserve data.

The Mortgage Bankers Association reports that about $1 trillion of those mortgages will mature from 2010 through 2016. But because banks will have tighter underwriting standards, a massive wave of defaults is almost certain.

Most commercial property owners will be unable to meet the revised terms of mortgages upon renewal and will be unable to borrow much from banks. That will cause either huge numbers of mortgage extensions or a large volume of properties turned over to lenders, resulting in severe market disruption.

The federal government won't be able to finance big rescue efforts because too much of its money will be committed to the elderly. Medicare and Medicaid entitlements, net of premiums, will rise from $681 billion in 2010 to $995 billion in 2015. Social Security benefits, excluding amounts paid in, will increase from $521.4 billion to $674.9 billion.

So total health and income spending will rise from $1.2 trillion in 2010 to $1.7 trillion in 2015. Such spending will increase from 36.3% of all federal outlays in 2010 to 46.6% in 2015.

Thus, spending on the elderly at current rates will essentially cripple all other federally financed activities. Yet fear of alienating older voters is paralyzing the federal government from achieving a better balance in the use of its funds. If this outcome doesn't change, it will prolong our current recession and weaken our eventual recovery.